The Economist Intelligence Unit

China in focus

How big is the middle class?

The middle class, while growing rapidly, remains small and geographically disparate.

The emergence of China as a mass consumption market is a mainstay of any article arguing that the country is on track to become an economic superpower. But it will be decades before the Chinese middle class matches its counterparts in the US and Europe as a consumption force. The middle class, while growing rapidly, remains small and geographically disparate, thus continuing to present challenges to foreign companies seeking to tap growing consumption demand.

Over-hyped consumption data

Government figures claiming double-digit percentage increases in retail sales overstate the increase in private consumption spending in China. Government figures show the category of "retail sales" rising by 18.3% in nominal terms (or 14.8% in real terms) in 2010 to Rmb15.7trn (US$2.3trn). However, retail sales data far exceed private consumption spending figures because wholesale and some government purchases are included in the data.

The breakdown of GDP by expenditure shows private consumption spending of only Rmb13.3trn, a real increase of only 5.1%. At more than 5 percentage points below real GDP growth, this means the share of private consumption in the overall economy is falling. This continued into the first three quarters of 2011, when real GDP grew by 9.4% year on year. In contrast, per-head consumption of urban households rose by just 6.7% year on year, even as total retail sales grew by 17%.

How large is the middle class?

As such, a mass-consumption culture has yet to fully emerge in Chinese cities. There has been rapid growth of a still proportionately small middle class, but the definition and size of this key group of consumers remains debatable. The phrase "middle class" is as much a cultural concept as an economic one. The Chinese Academy of Social Sciences (CASS), a government think tank, recently published figures in its 2011 City Blue Book claiming that 37% of China's urban resident population, or 230m people, fell into the category of "middle class". However, this figure is slightly misleading to retailers looking to tap into the Chinese market. The definition of "middle class" used in that source is households with per–head disposable income of Rmb16,300-37,300 a year in 2009 (around US$2,400-5,500 at the then prevailing exchange rate). However, a disposable income of US$2,400 a year is unlikely to be what a Western business has in mind when it aims to make sales to "middle-class" Chinese.

It seems more logical to take the CASS figure of 230m as referring, not to a genuine middle class with consumption patterns rivalling that of the Western middle class, but to consumers with some discretionary spending power. As this 230m have disposable incomes of between US$2,400 and US$5,500, the number of Chinese with significant discretionary spending power can be narrowed down to the upper end of the range, and, making allowances for under-reporting of income, arrive at a rough estimate of 100m-200m.

However an estimate of the numbers of Chinese with true "middle-class" lifestyles, comparable to those of the West, would be much smaller than this. There are few Chinese provinces with enough people earning more than Rmb120,000 a year (roughly US$20,000 a year)a level of disposable income more comparable to the Western middle classto be captured in statistical data. In 2010, the greatest concentration of such people was in the Yangtze River Delta, with 173,000 such people in Shanghai, 173,000 in neighbouring Jiangsu province and 166,000 in neighbouring Zhejiang province. The Economist Intelligence Unit estimates that the only other provinces with residents earning that much are Liaoning (64,300), Beijing (62,200), and Fujian (24,100). So, even in China's most prosperous cities and provinces, declared incomes of US$20,000 a year are rare. While there are likely to be some well-heeled consumers in western provinces, the numbers are very low. Nationally, the number of people reaching these income levels is in the low tens of millions (a figure supported by China's healthy car sales data), not the hundreds of millions.

Chinese incomes generally translate into better than expected lifestyles when calculated on a purchasing power parity (PPP) basis, but PPP conversions are nevertheless less relevant when it comes to big-ticket consumer items, such as cars and computers, which are often sold for approximately the same prices in China as in the developed West. Indeed, some consumer products are more expensive in China than in the West (not least owing to luxury taxes on a wide range of goods). Consumer credit in China is much less developed than in the West, further limiting consumer spending. In 2010 a US financial services company, Mastercard, said that it expected the number of credit cards in China to exceed that of the US only by 2020. As such, companies selling at the more-affordable end of consumer products like white goods and clothing are more likely to do well, as seen by the success of lower-priced brands like Haier, a Chinese appliances company. Nevertheless, China does have significant pockets of prosperity, enough to ensure that the Chinese car market is now the largest in the world. In 2010, 13.8m passenger cars were sold in China, ahead of the 11.5m sold in the US.

However you define it, the middle class is set to grow rapidly

Historical experience in other economies indicates that an economy with a GDP per head of around US$5,000 is at the threshold of the emergence of a much larger middle class. China's GDP was equivalent to a per-head level of US$4,520 in 2010. Taking into account the low contribution of private consumption to GDP33.2% in 2010and efforts to rebalance the economy towards private consumption demand, China is expected to achieve a significant rise in per-head consumption levels. The EIU forecasts that private consumption will rise from US$1,500 per head in 2010 to US$4,090 per head in 2016.

The number of Chinese earning more than Rmb120,000 is forecast to rise to around 35m by 2020, skewed towards the Pearl and Yangtze River deltas. Guangdong province (including Guangzhou and Shenzhen) is forecast to have 10m residents earning more than Rmb120,000 a year in 2020. The provinces of Zhejiang, Jiangsu and Shanghai are forecast to have 3.1m, 3.9m and 1.8m. These two small and distinct geographical regions will therefore have the vast majority of truly middle-class consumers. Beijing and Tianjin are forecast to have 1.3m each, with 1.3m in Hunan province, a considerably less prosperous region in the centre of China. Foreign companies seeking success in the newer nodes of affluence would do well to understand that their targeted markets remain relatively small. Even though prosperity is beginning to spread west, the EIU estimates that there will only be 944,000 consumers with incomes above Rmb120,000 in Sichuan and 365,000 in Chongqing by that time.

The bulk of the Chinese middle class will remain in these two distinct geographical regions in 2020, albeit massively expanded in numbers from now. With continual urbanisation in China, a tighter labour market (leading to higher income growth), the appreciation of the renminbi and banking-sector reforms likely to eventually boost the household consumption sector of the economy, China is set for a gradual shift towards a mass consumption economy by the 2030s.

The large geographical distances between the nodes of prosperity make tapping China's middle-class consumption demand less straightforward than is the case in advanced economies. This should gradually improve as the prosperous areas begin to link up geographically in the 2020s. The pool of middle class consumers in industrialised economies is unlikely to grow significantly in coming years, so foreign investors have a strong incentive to tap the Chinese market, given its potential. But Chinese companies will have their eye on the same prize.

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